Current issues in economics

Tag Archives: Debt

Although the attention this morning was on the election of Donald Trump as US President the RBNZ cut the OCR to 1.75% with a mild easing bias of “numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly”.

It is expected that the OCR will remain at this level in the near future with inflation expected to be back within the 1-3% Policy Target Agreement (PTA) by the end of January next year – see graph from ASB Bank. The reason for this is that:

Dairy prices have recovered considerably.

The labour market is tightening.

Growth is running at an above-trend pace.

The OCR is already at an expansionary rate and the economy.

Could there be another cut in the OCR? There would be pressure if the following eventuated:

there is a strengthening of the NZ dollar,

increasing bank funding costs,

any further weakness in inflation expectations,

any deterioration in the global growth outlook.

The change of US Presidency will also be a wildcard over the longer term, with its mix of potential fiscal stimulus and trade protectionism. Trump has already signaled that he is not keen to sign TPP and he wants to reopen the NAFTA – North America Free Trade Agreement. Furthermore, he might take umbrage on the Chinese with their manipulation of the Yuan to advantage its exports and put a large tariff on its goods coming into the US. For New Zealand it may mean that they have to go down the bi-lateral agreement option in order to increase trade.

Other than the US election, Graeme Wheeler needs to be aware of the following:

Theresa May has indicated she wants to trigger Article 50 by May 2017 – it is very unclear what the process will be and the negotiating strategy of both the UK and the EU. This could have implications for NZ trade.

In China the increasing of centalised power of the President.

China has a huge amount of corporate debt relative to GDP – see graph below.

Household debt in New Zealand is now equivalent to 163% of annual household disposable income – see graph below. Record low interest rates has seen credit growth rising at a pace not seen since 2008. How do low interest rates contribute to this?

Household debt as a share of disposable income (including investment housing)

Low borrowing rates have made it easier to purchase property with bank funds especially as the supply of housing hasn’t matched the increase in demand. The strong growth in property prices has meant that those who already own a house are using that security to purchase additional property. According to the IMF New Zealand has the highest ‘House Price-to-Income Ratio’ – see graph below.

Other parts of the world are experiencing high household-debt to income levels (see graph below) but does high debt levels mean that the economy is going to hit a major recession? Since the credit crisis of 2008 the global financial system has seen tighter regulations put in place to improve stability with banks limiting access to credit so there is less exposure to the risks associated with highly leverage lending.

Growth in house prices and household credit 2011 – 2015.

However debt servicing remains tolerable with low interest rates and much of the debt secured against investment housing. Also debt-to-asset ratios have fallen to levels that were experienced in 2007 but this has eventuated from low interest rates which have boosted house prices. Ultimately with a fall in house prices, and depending on its severity, those who recently entered the property market would suffer some degree of hardship whilst those already well established in the market might have a financial buffer.

Debt and future growth in New Zealand

Household debt still has implications for the long-term growth of the economy.

With larger proportions of their income being allocated to debt consumers have less disposable income for other goods and services which creates less aggregate demand.

High debt levels mean households have more exposure to unfavorable economic conditions that could lead to rising unemployment. In this case they have less money to fall back on.

The December 2015 edition of the New Internationalist discussed 10 Economic Myths that need to be addressed especially after the GFC. Below is the list and the NI goes through each in detail – click here to go to the NI website.

Myth 1: Austerity will lead to ‘jobs and growth – ‘ It’s wrong to sell austerity as a cure for economic woesMyth 2: Deficit reduction is the only way out of a slump - Don’t rely on those who caused the crash to resolve itMyth 3: Taxing the rich scares off investors and stalls economic performance – Taxation creates prosperity just as much as private enterpriseMyth 4: Economic migrants are a drain on rich world economies – Migration follows a demand for labour and benefits the receiving countryMyth 5: The private sector is more efficient than the public sector – There is no evidence of greater efficiencyMyth 6: Fossil fuels are more economically viable than renewables – Not if you look at the environmental costsMyth 7: Financial regulation will destroy a profitable banking sector – Why should financial markets be accountable only to themselves?Myth 8: Organized labour is regressive – It can be argued that the opposite is actually true.Myth 9: Everyone has to pay their debts – We need debt management not reductionMyth 10: Growth is the only way – why we need to find another way, fast.

Although it is repetitive in places especially when they talk of debt and austerity it does provide some valid arguments. I think that the last myth ‘Growth is the only way’ is of particular importance in that GDP growth at all costs has led to wasteful resource use, particularly by the wealthier countries, on an unparalleled scale and without a backward glance. It is often noted that the economy is a subset of the ecological system, but equally there seems to be a belief that nature can cope with anything we throw at it. However, an assessment by the Global Footprint Network indicates we are running a dangerous ecological debt. Currently the global use of resources and amounts of waste generated per year would require one and a half planet Earths to be sustainable (see graph below). The price to be paid for this overshoot is ecological crises (think forests, fisheries, freshwater and the climatic system), a price that is again paid disproportionately by the poor.

Another report from Paul Mason in Greece where he explains the third bailout package. He also meets a doctor whose hospital has had its budget slashed from €19 million to €7 million and who says the deal is ‘a crime against humanity’.

A HT to colleague David Parr for this piece from The Sydney Morning Herald. Apple are currently worth $US194 billion in cash and securities which equates to €178 billion. This means that Apple have enough to cover the €86 billion Greek bailout deal struck earlier in the week twice over — with a cool €6 billion still left over to maybe buy an island or a port. If Apple were a country, it’d be the 55th richest country in the world.

According to the World Bank’s most recent data on national wealth, Apple is now worth more than the following countries:

Brian Gaynor in the NZ Herald wrote an article on New Zealand’s debt position. There are two important figures to note:

1. Gross external debt, which is the country’s total overseas debt.
2. Net external dent, which is determined by subtracting New Zealand’s gross overseas lending from its gross external debt.

New Zealand Government debt is currently $54.9 billion with total Government debt (external plus domestic) representing 38% of GDP. This is low by international standards. The biggest contributors to New Zealand’s external external debt are the registered banks which now account for $117.9 billion. The banks increased their overseas borrowings from $55.2 billion in 2001 to 139.5 billion in 2008. However since the GFC, banks have reduced their borrowing from overseas by $21.9 billion which is a positive development. However the big concern for New Zealand is that with a small financial market domestic borrowers source a lot of their debt from overseas lenders. New Zealand would be in a much stronger position if its financial markets could fund domestic borrowers.

A number of articles from The New Yorker magazine have outlined the problems facing Greece’s anti-austerity party Syriza. The party came to power on the election promise of reducing Greece’s debt burden and to liberate Greece from the Troika – the ECB, the IMF and the European Commission. However the extension recently granted to Greece will take place only within the framework of the existing arrangement. The budgetary targets for 2015 and 2016 have kept the economy stuck in recession.

* the Greek economy has contracted by 30% since 2008.
* 25% of the workforce are officially unemployed
* 50% of those under 24 years of age are unemployed
* 40% of Greek children live below the poverty line.

Money has been flowing out of the economy leaving the banking system on the verge of collapse see graphic from The Economist.

As with the Keynesian doctrine, Syriza’s solution in to create effective demand by pumping money into the system. One economics professor at the University of Athens called it “pure Keynesian policies. The big question is where will the money come from although some seem to think that it can raise revenue from tackling corruption and tax evasion. The latter is widespread in Greece amongst the upper-middle class and the very rich – the top-most bracket of households and businesses are responsible for 80% of the total tax debt owed to the government.

Greece’s creditors were mostly European banks, which had, in part, used public bailout money following the 2008 credit crunch to scoop up Greek bonds. For example, French and German banks were on the books for thirty-one and twenty-three billion euros, respectively. The troika stepped in during the spring of 2010, and again in 2012, to orchestrate bailouts of the Greek government, offering two hundred and forty billion euros in loans in exchange for a drastic reduction in government spending and other measures to make the Greek economy more competitive. Source: New Yorker

Grexit
The conventional wisdom is that returning to the drachma would be a catastrophe for Greece. There are pros and cons to this decision – the following would be concerns about returning to the drachma:
* An immediate devaluation;
* The value of savings would tumble;
* The price of imported goods would soar.

However on the positive side of things you would get the following:
* Greek exports would become cheaper
* Labour costs even more competitive.
* Tourism would likely boom.
* Regaining control of its monetary and fiscal policy for the first time since 2001

It would give Greece the chance to deal with its economic woes. Other countries that have endured sudden devaluations have often found that long-term gain outweighs short-term pain. When Argentina defaulted and devalued the peso, in 2001, months of economic chaos were followed by years of rapid growth. Iceland had a similar experience after the financial crisis. The Greek situation would entail an entirely new currency rather than just a devaluation.
This conflict is as much about the ideology of austerity and whether smaller countries will have a meaningful say in their own economic fate. However one needs look back in history to remember that in debt-saddled Weimar German, humiliation and dispossession festered until it a gave rise to the Nazi party. Greece’s neo-nazi party won the third greatest number of parliament seats in the last election.

Here is a chart that I use to explain how mainstream economists before the GFC tended to view debt – loss to creditors but gains to debtors = a zero sum game. However this has been shown to be fundamentally wrong since the GFC.

Brian Gaynor in the NZ Herald wrote a piece on the amount of debt in the New Zealand economy and the fact that the Reserve Bank needs some fresh ideas to stem the increasing trend. With the OCR increasing this week to 3.5% the disposable income of the floating mortgage holder will reduce and ultimately impact on their ability to spend – floating mortgages represent 33% of all mortgages in dollar terms. Although higher rates help those that have money in the bank however a lot of this is from overseas investors so interest payments leave the economy. Furthermore the elderly tend to have savings in banks but they are not seen as significant spenders. The higher interest rates also attract ‘hot money’ as NZ’s rates are higher than most other industrialised countries.

The amount of debt in the economy is a major concern especially when you consider how much is mortgage debt – see below. Also the fact that debt as % GDP is now 88.5% and 145% of disposable income – this is putting pressure on inflation not forgetting that people are living very much beyond their means.

The RBNZ is concerned with this debt and introduced restrictions on high loan-to-value residential mortgage lending. They see that there is too much emphasis on housing which is being fuelled by greater access to debt. One only has to look at the Irish property to see how things can wrong – house prices dropped 50% between 2007 and 2012.

Below is a flow chart that shows some of the causes of financial instability in the global economy. Below are the the main points:

* The mismatch in the banking system with regards to paying debt
* Low interest rates and lack collateral required means more lending
* Good debt – productive use in capital investment (however very limited in most countries)
* Bad debt – non-productive assets used for speculation purposes (popular with investors)
* Capital Flows – Governments can fund current a/c deficits with borrowing from overseas
* From this further increases in the supply of money and therefore lending.
* Ends with a property bubble.